Why Do “Good Institutions” Fail? A Political Settlements Critique of New Institutional Economics

Abstract

Purpose | This article critically assesses New Institutional Economics (NIE) and its policy-oriented counterpart, the “good governance” agenda, which have been central to development economics for decades. The paper highlights the limitations of this mainstream approach, particularly the frequent failure of NIE-inspired reforms in contexts of political instability. It proposes the “political settlements” framework, developed by Mushtaq Khan, as a more effective alternative for analyzing development processes. Research method | The study is based on a critical literature review and a comparative analysis of competing theoretical frameworks. It synthesizes insights from NIE, including the work of North, Wallis, and Weingast (NWW) and Acemoglu and Robinson, and contrasts them with the political settlements approach to identify the shortcomings of the dominant paradigm. Results | The analysis concludes that NIE and the “good governance” agenda often fail because they promote the transfer of institutional models from developed countries without adequately considering the local distribution of power and informal norms. In contrast, the political settlements approach offers a more realistic framework by focusing on the actual balance of power, termed “holding power”, and its role in shaping institutions as mechanisms for distributing benefits. While acknowledging the evolution within NIE and the criticisms directed at the political settlements approach (e.g., its tautological nature and difficulties in operationalization), the authors find Khan’s framework to be a superior tool for understanding political and economic realities in developing countries. Originality / value / implications / recommendations | The paper’s value lies in its direct juxtaposition of the idealized, rules-based perspective of NIE with the power-centric realism of the political settlements approach. It provides a critique of the dominant development paradigm, arguing that grounding the analysis of institutions in the actual distribution of power is essential for understanding why “good institutions” often fail. This provides a crucial alternative perspective for researchers and policymakers engaged in analyzing development and institutional change.